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Richard Bernstein’s latest research piece has a view that I very
much agree with. The Fed is traditionally a reactive
entity. When the economy is running hot they tend to lag
the market and tighten too late. When the economy is
running cold they show up late to the party as they did in 2008.
On both sides they end up playing catch-up which results in
whip-sawing the economy in a way that actually causes more
economic volatility than necessary.

“The Fed believes that reversing QE will slow the economy.
However, a steeping yield curve and stronger business
confidence argue otherwise. If we are correct, then the Fed
could once again be forced to play catch-up to the markets
during the mid- and late-cycle.As most cycles mature, the Fed
typically realizes that their policies have been too
accommodative for the maturity of the cycle. Production
bottlenecks and shortages become more frequent, and inflation
pressures begin to build. The Fed then rushes to tighten
monetary policy in an attempt to make up for the earlier
hesitancy to tighten. The traditional end result has been that
the Fed’s late-cycle aggressive policies go to far (i.e., they
over-tighten policy), the yield curve inverts, and a recession
follows.

This cycle seems poised to follow that historical pattern. The
Fed remains fearful of tightening too early and has told
investors that they will react to the economy’s strength. Their
reaction time will probably be slow as well. If our contention
that reversing QE might stimulate the economy is correct, then
the frequency and magnitude of Fed tightening is likely to
accelerate as they realize they’ve created a monster. Their
rush to equalize monetary policy with the strength in the
economy could lead them to over-tighten and invert the yield
curve. A recession would probably follow, and the cycle would
end in a very traditional manner.”

That makes a lot of sense given this cycle. We’ve seen such
a historic easing program that the Fed is going to be very
hesitant unwinding the program. They want to be completely
certain that the economy is healed before they jump the gun.
And by the time they do that they’ll almost certainly be
behind the curve as a disequilibrium will already be building up
in the economy.

We live in a boom/bust era dominated by Fed policy. In my
opinion, we can thank Milton Friedman for this obsession with Fed
policy and the assumption that the Federal Reserve and a group of
economists can control the economy with any sort of precision.
The 30 year experiment with the Federal Reserve’s
interventionist policies is far from over.